Tuesday, November 27, 2007

Stocks In November

INVESTING BACKGROUND

I run three trust funds for my nephews and nieces that are old enough to understand the concept of saving, investing and stock selections that are documented at the site www.trustfundsforkids.com. I don't mind directing people over there because there are no ads and it just describes what the funds are about, our selections, and our returns. Here is a post with more background on the topic.

RECENT EVENTS

For anyone who has been following the markets this year, it has been a roller coaster ride. The US stock indices were up for the year with some decent gains but have recently given up almost all of those gains and seem to be in a state of flux right now. High oil prices, the falling dollar, the credit freeze, housing woes, and finally massive write-offs in the financial sector have taken their toll.

Another important element that is coming to light is that profits for US companies are down significantly; per Barron's the Q3 EPS for companies reporting are down 8.5% from the prior year - this is a big downturn, comparable to the quarters right before prior recessions (1989 and 2000). Without profit improvements, hiring and capital spending tend to fall in a bad spiral.

One term to keep in mind when investing is "negative covariance" - in layman's terms this means that "bad things tend to occur at the same time". Thus everything is fine, and then it's not. For instance, the housing market goes down, liquidity evaporates, banks make huge write-downs, and then the companies that guarantee or eat these debt instruments struggle to understand the damage. These items were all related, and while models may value the probabilities of each individually, they all work together (in a bad way).

The stock markets recently went down about 10% - this is now officially a "correction". No one knows if this is the start of a long swoon or a "buy on the dips" opportunity.

FOREIGN MARKETS

To a significant extent our trust funds have shied away from these issues by investing in foreign stock markets (check here for a recent post on the topic). For someone starting out today, I would recommend that a decent portion of the total portfolio be in overseas markets since the US economy is a declining share of the total world GNP and much of the growth is occurring overseas.

With this recommendation, of course, comes caveats. Many of these markets have a history of boom and bust, and while improving, their financial reporting and investor protections are not always as strong as the traditional US / UK financial markets.

We made some selections in the overseas markets, notably China Mobile (CHL) and ICICI Bank (IBN) in India, as well as BHP Billiton (BHP) in Australia. Each of these stocks had a great ride upward and then I put in stops and we sold recently rather than (potentially) watch these gains evaporate. Of course, I can't see the future any better that anyone else, and potentially we gave up some big gains in the future, but I thought that the China market in particular was giving off the odor of a "bubble" and figured that it was best to be prudent.

RECENT RECOMMENDATIONS

The problem with selling and gains (beyond paying taxes, which I describe in the site and also will document on the blog in 2008 when I need to make the calculations) is that the money needs to be put back to work. I realize that true market-timers might say that this is a good time to sit on the money (and I personally have been putting more into cash right now) but for the purpose of these funds they have a long horizon and I need to keep investing for the long term, which means stocks.

Thus I had to scratch my head and come up with some more recommendations, featuring a lot of companies from Japan and Mexico which I think have a lot of room to grow (along with their economies) and also some potentially undervalued or reasonably stable US companies. Since the portfolio horizon is long, I also try to encourage selecting some high growth (high risk) companies that might make a big return or be a flop.

One of my stubborn relatives was scoffing at putting the money to work when the indicators were down (newspaper headlines) and I told him that the damn money mostly wasn't in the US anyways, so he was looking at the wrong headlines. Also, if he or anyone else is smart enough to market time god bless them they should be on an island somewhere like at the end of "Trading Places" because that is where you'd end up if you had that kind of power over time and space.

For some reason blogger doesn't allow linking to PDF files as if they were pictures so here is a link to the recommendations PDF file that is out on my other web site. I also include past recommendations so you can see what you think and come up with your own conclusions as well as see performance of the portfolios so far on the site. The items in RED are recommended and the rest are there for completeness sake.

As always, do your own homework, and I am not recommending that individuals select stocks as opposed to market tracking ETF's for their own purposes. Due to the unique nature of these trust funds and the fact that I am trying to use this as a teaching experience as well as an investing vehicle, individual stocks make more sense than using hard-to-conceptually-understand ETF index tracking funds. I also know that these trust funds are not the most tax-advantaged investing vehicle, but the fact that ownership is clear makes up for this impact (in my mind, at least). Go to LITGM and check the "taxes" or "investing" sidebar for more articles on these topics.